WEEKLY REVIEW | ISSUE 325b | 30 julY–5 august 2011 CONTENTS IN THIS ISSUE... STOCK REVIEWS STOCK ASX CODE REcoMMENdaTioN PAGE AWE AWE Speculative Buy 9 James Greenhalgh Bega Cheese BGA Avoid 3 Over the past 18 months we’ve recommended you increase your Fantastic Holdings FAN No View 5 Kathmandu KMD No View 5 cash holdings. Today is a day when you might want to deploy some OrotonGroup ORL No View 5 of it. This is where to look... (see page 2) Premier Investments PMV No View 5 Super Retail Group SUL No View 5 The Reject Shop TRS No View 5 James Greenhalgh stock UPdates Bega Cheese is definitely not the cold cabinet equivalent of Coca Australand Holdings ALZ Long Term Buy 11 Cola. Welcome to one of the worst floats in years... (see page 3) Macquarie Group MQG Buy 11 Rio Tinto RIO Sell 12 features John Addis Opportunities amid the falls 2 Does mid-2011 feel a little like late 2006? Many things could go Apocalyptic horsemen and their prices 4 wrong but one salient fact points to courage over fear... (see page 4) Doddsville blog | Want to avoid the next crash? Avoid the cranes 12 EXtras Podcast & Video links 13 James Greenhalgh Twitter links 14 Ask the Expert Q&As 14 In the final part of our retail review, James Greenhalgh examines RecomMendation changes which small retailers might prosper, which won’t, and the prices at which they’re worth revisiting... (see page 6) Australand upgraded from Hold to Long Term Buy Bega Cheese coverage initiated with Avoid Macquarie Group upgraded from Long Term Buy to Buy Santos upgraded from Hold to Long Term Buy Gaurav Sodhi PORTFOLIO CHANGES The revolution that has transformed the American energy market There are no recent portfolio transactions has reached AWE. Shale gas is here, AWE has it and no one has noticed... (see page 9) Nathan Bell On a sunny August day in 1929 failed presidential hopeful Alfred E. Smith gathered the New York press and announced humble plans to build the world’s tallest skyscraper... (see page 12) Intelligent Investor Over the past 18 months we’ve recommended you increase your cash holdings. Today is a day when you might want to deploy some of it. This is where to look. Buffett famously said, ‘be greedy when others are fearful’. But it’s easier said than done. With the US market falling around 5% overnight, ‘being greedy’ might be the last thing on your mind. But cast your mind back to March 2009. When everyone was panicking, some of the best buying opportunities in a decade arose amongst the turmoil. This sell-off may offer some equally good bargains. But why are people panicking in the first place? The recent panic, which has seen some companies’ share prices tumble to 2009 lows or below, is the result of a flood of disappointing news. First, the US manufacturing sector, and the economy as a whole, isn’t recovering as expected. Second, the Japanese have had to intervene in their economy to weaken the Yen and finally, the European Central Bank has announced it will re-enter the bond market to buy debt from troubled countries (Greece and Spain). Reignite fears This has combined to reignite fears about both the health of the global economy and government’s ability to manage spiralling deficits. While the problems are real—governments do need to rein in spending and the economy isn’t recovering as fast as expected—in many cases share prices reflect the bad news. Our market is today following the global lead. This is a perfect opportunity to deploy some of the cash we’ve been encouraging you to hold. What follows is a number of key recommendations and the prices where we’d be willing to upgrade. It’s not necessarily comprehensive, as we’ve produced it quickly this morning. Bear in mind that you shouldn’t fire all your bullets at once—better opportunities may be round the corner. And don’t forget to stick to the portfolio limits which you can find in each stock review. We’re holding fire on the banks in particular and reiterate you should keep bank holdings to less than 10% of your portfolio and financials to less than 25% in total (much less if you’re conservative). Opportunities like today should be used to deploy cash (sensibly, of course). Use the watch list that follows to focus your attention. TabLE 1: THE WATCH LIST COMpaNY LAST REVIEW (REco - PricE) UpgradE? AbacUS PropERTY (ABP) Hold—$2.21 Long Term Buy at $2.20 ARB CorporaTioN (ARP) Hold—$7.80 Long Term Buy at $7.00 BrickWorkS (BKW) Long Term Buy—$10.10 Buy at $9.00 COMPUTERSHARE (CPU) Long Term Buy—$9.19 Buy at $7.00 CSL (CSL) Long Term Buy—$32.82 Buy at $25.00 INSUraNCE AUSTraLIA (IAG) Long Term Buy—$3.27 Buy at $3.00 MacQUariE GroUP (MQG) Buy—$25.05 Strong Buy at $23.00 MAP GroUP (MAP) Long Term Buy—$3.44 Buy at $2.80 NEWS Corp NON-VOTING (NWSLV) Long Term Buy—$14.10 Buy at $12.50 PErpETUAL (PPT) Buy—$24.64 N/a PLATINUM ASSET (PTM) Long Term Buy—$4.74 Buy at $3.60 QBE INSUraNCE (QBE) Buy—$16.65 Strong Buy at $15.00 SoNic HEALTHcarE (SHL) Hold—$12.63 Long Term Buy at $12.00 WESTFIELD GroUP (WDC) Long Term Buy—$8.61 Buy at $7.50 WESTFIELD RETaiL (WRT) Long Term Buy—$2.69 Buy at $2.30 WoodSidE (WPL) Hold—$38.92 Long Term Buy at $35.00 WooLWorTHS (WOW) Long Term Buy—$26.20 Buy at $24.00 2 Weekly Review | Issue 325b Bega Cheese is definitely not the cold cabinet equivalent of Coca Cola. Welcome to one of the worst floats in years. KEY PoiNTS Brand benefits have been sold off Commsec boldly declares Bega Cheese ‘an opportunity to invest in a highly recognised Serious conflicts of interest, low quality business Australian household brand’. If only that sentence weren’t so loaded. High float price Powerful consumer brands enjoy massive pricing power and can be fantastically profitable. If Bega Cheese is the Nike, Apple or Coca Cola of the cold cabinet, why wouldn’t you be interested? The point is rammed home on the Commsec website, where the Bega float is prominently featured, and in the prospectus itself (see page 8 and 12, for example). The problem is that the pictures tell one story and the facts quite another. There are so many things to dislike about this float it’s hard to know where to begin. But let’s start where the promoters would like us to; with the brand. Whilst Bega appears to be a brand-driven business, it’s actually a low margin, contract dairy manufacturer. It buys milk and makes it into things like cheese, milk powders, infant formula, butter and cream, which are sold to powerful customers like Kraft, Fonterra and Aldi, all of whom excel at squeezing the very last cent from their supplier. The result is that what should be a high margin brand-based business actually generates pitiful net profit margins of around 2%. BEga CHEESE | BGA It’s worth explaining why. Bega Cheese technically owns the Bega brand but it sold the economic rights to it (in Australia) to Fonterra 10 years ago. In return, it received a one-off PricE AT REVIEW $2.00 payment of $35m, now long since spent, and an ongoing royalty of 2.5% of sales revenue a year. REVIEW daTE 1 Aug 2011 If you can imagine Coca-Cola licensing its brand name for a woefully small sum and then BUSINESS RISK 4 buying up bottling plants in order to use it, you get an idea of the Bega Cheese strategy. SHarE pricE riSK 4 Who knows what was going on a decade ago but Bega must have been desperate. OUR ViEW AVoid Conflicts of interest TabLE 1: KEY INForMATioN The second major reason not to invest in this float is that, as a shareholder, the company probably won’t be run in your interests. If you find that hard to believe, turn to page 14 of ProSPECTUS daTE 18 July 2011 the prospectus, where it is spelled out. CLOSE OF RETaiL OFFER 16 August 11 Since 1899, Bega has been owned by dairy farmers. The scale of operations has LiSTING daTE 29 August 11 expanded (see Table 2) but not much else. With farmers holding 85% of the stock after the No OF SHarES (M) 18.4 (of 127) float, they will be pulling the udders and the strings. The basis of public companies is that LiST pricE ($) 2.00 managers are expected to act in the interest of all shareholders but as it says in black and white on page 14, ‘[Farm shareholders] may take a different view [to other shareholders] MarkET capiTALISATioN ($M) 254 as to what is in the best interests of the Company’. 2011 PER* 16.7 2011 DIV. YIELD (%)^ 2.90 Milking the benefits ^Based on pay out ratio of 50% This astounding admission makes some sense, if you happen to be a farmer and current Bega shareholder. You see, farmers sell their milk to Bega. They may choose to make their CHarT 1:BGA FY2011F ProdUCTioN money from this business not from building the value of their shareholding but by selling Cheddar Cheese 10% milk to their company at above market prices. Cream Cheese 7% Indeed, farm gate prices in the Bega region are some of the highest in the country.